Lecture 10

It is easy to show again for you to show that the

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Unformatted text preview: ent claim, the price of the state s Arrow security times the price of good k in the state s spot market. It is easy to show (again, for you to show) that the relative prices across states is the same as that under contingent claims. The same applies to relative prices within each state. A complete set of Arrow securities is sufficient to replicate the equilibrium with full contingent claims. Here, we have K spot markets at Date 0 and at each future state (for a total of 1 as well as the Arrow securities traded at Date 0. Ordinary Securities Arrow securities are really a special case of ordinary securities, i.e., securities that pay off a state‐contingent amount of purchasing power at any particular , ,..., . If there state. The return on ordinary security m is: ≡ are M ordinary securities, the payoff matrix can be written as: … ⋱ … ⋮ ⋮ i.e., the first column of represents the payoff of ordinary security 1, the second column of ordinary security 2, ... . Reading across rows gives you how much one would receive in each state if you...
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